Will the FTSE feel the January effect in 2020?
In an attempt to cut through the deluge of noise that faces them every single day, investors can be tempted – quite understandably – to use a few rules of thumb to at least set them on their way when it comes to starting their research. One old saw is the saying that a good start in January means the year as a whole is likely to see positive returns.
Looking at the history of the FTSE 100 since its inception in 1984, you can see why someone might be tempted to put some credence in this adage. After all, seven of the index’s ten best years, in terms of capital gains, came when it got off to a flyer in January and seven of its ten worst showings came after a drop in the first month of the year.
“Seven of the [FTSE 100’s] ten best years, in terms of capital gains, came when it got off to a flyer in January and seven of its ten worst showings [since its inception in 1984] came after a drop in the first month of the year.”
January can help to set the tone for the rest of the year
Source: Refinitiv data
Investors could therefore be forgiven for fearing the worst after the heavy sell-off in the last two days of January left the FTSE 100 down 3.8% for the month. That is the weakest start to the year since 2014.
The January stumble also means the FTSE 100 has, at the time of writing, lost all of the gains made in the immediate aftermath of last December’s General Election results. The optimism sparked by that result, in some quarters at least, appears to be dissipating and this can also be seen in the sector performance data within the FTSE 350 since the turn of the year.
“Sector performance data within the FTSE 350 since the turn of the year [also points to a loss of confidence].”
Defensive sectors have done best so far in 2020
Source: Refinitiv data
Granted, the Household Goods sector has done well, thanks to the presence of the house-builders and hopes for further measures from the Government to support the housing market. But otherwise, defensive areas such as Utilities, Food Producers and Tobacco are to the fore. By contrast, cyclical areas such as Chemicals, Industrial Transportation, Industrial Metals, and Forestry and Paper are in the doldrums.
The wall of worry
This loss of confidence can also be seen in how the yield on the benchmark UK ten-year Government bond, or Gilt, slumped from a high of 0.87% to just 0.55% in January, as investors piled into fixed income.
But what the fresh drop in Gilt yields (and increase in Gilt prices) and latest fall in share prices all mean is that UK stocks look even cheaper relative to bonds than they did before, especially on a yield basis. This column’s data only goes back to the mid-1990s for UK Gilts, but the chart makes it clear that the premium yield offered by the FTSE 100 relative to the 10-year Gilt stands at a record high, at almost 3.9 percentage points, or 390 basis points. (Research from the fund management group Man GLG suggests the premium is the highest it has been since 1939, when Europe was preoccupied with an imminent war.)
FTSE 100’s yield premium over Gilts stands at a multi-year high
Source: Refinitiv data
“The dividend yield therefore remains a key part of the investment case for UK equities, although sceptics will counter that there are three good reasons why the UK offers a premium yield.”
The dividend yield therefore remains a key part of the investment case for UK equities, although sceptics will counter that there are three good reasons why the UK offers a premium yield – and the main one is the risk associated with owning UK equities. Investors are, for now, demanding that premium yield to compensate themselves for three perceived dangers in particular.
Investors were also demanding a premium risk to help compensate them for the risk – as it was seen – of a Labour Government. That risk has passed for five years (in theory) and as a result, share prices initially gained and the dividend yield came down.
It therefore stands to reason that share prices could go higher again, further decreasing the yield, if these new fears are assuaged and investors become more confident in the prospects for UK stocks. This is, in some regard, a long-winded way to reaffirm another old saying about how ‘markets like to climb the wall of worry’, although some advisers and clients may feel that there are too many ‘ifs’ for their tastes for now when it comes to allocating capital to UK equities.